Do Central Banks Really Control Interest Rates?

Everyone believes that the modern central bank is an omnipotent economic force. What if it isn’t? What if it can’t even do the most basic of things that it says it can – control interest rates?

QE vs The SRF: Shackled By A Poor Diagnosis

Fed misdiagnoses problems in the repo market

It is entirely possible that the Fed does recognize the limitations of its domestic standing repo facility (SRF), but cannot do much about it.

After all, the Fed doesn’t issue USTs – that’s the Treasury’s job, which means that the Treasury is best placed to increase the amount of collateral in the financial system, by issuing more debt, specifically T Bills.

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Are You A Victim Of The Bank Reserves Myth? 1

Does the Fed actually control interest rates? No, it does not.

Previously, we discussed the Fed’s supposed control over interest rates through the perspective of their policy actions, centered on the fact that their policy rate decisions are timed against prevailing economic conditions.

However, this discussion is based on an important assumption – that their policies actually work. What if, in reality, the Fed’s policies do not work?

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Are You A Victim Of The Bank Reserves Myth? 2

Does the Fed actually control interest rates? No, it does not.

Central banks want to increase the money supply in the economy, but are failing to do so due to their belief in money multipliers and Fractional Reserve Banking, which are theories that are also based on the level of bank reserves in the system.

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Central Banks Focus On The Wrong Thing

What are the implications of the Fed’s current policy framework being invalidated?

An obvious and very important one is that debates and discussions are not occurring in the places where they can make the most impact, because the focus isn’t there.

If the focus isn’t there, then how can current problems be solved?

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Where Do Central Banks Need To Focus Their Attention? 1

You cannot solve current problems with current thinking. Current problems are the result of current thinking- Albert Einstein (paraphrased)

Which are the areas that can make the largest difference economically, and require Central Banks’ attention?

Quite simply, the ones which are currently ignored and not part of the mainstream conversation.

This includes problem areas like loan growth and credit market accessibility, the labor force participation rate, and money velocity.

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